Synergy

Synergy.

Charlie Munger once said, If we have only one way of operating we suffer from what is called as a Man with a hammer Syndrome.

The first picture that comes to my mind is Socialism. In their quest for equality, due to lack of second level thinking, they completely overlooked the second level effects of socialism in form of no respect for merit, tenure based promotions resulting in corruption, complacency and license raj. Our country’s leaders could have so easily copy pasted the master stroke of Benjamin franklin’s America but they had wrong idols. Our country suffered for decades because of socialism, alienating itself from USA.

So having only one way of thinking is a sure shot way to disaster, and therefore as per Charlie Munger one needs to be functional equivalent of Raymond’s Ad, THE COMPLETE MAN. Well dressed, groomed but not narcissist, empathetic, Rich yet charitable, sophisticated yet kind.

Almost reminds of my X Gf’s list of qualities she named for her to be husband to have, to which i said, sorry to break your amazing dream but anyone with such qualities, what compulsion would he have to stoop to your level.

Is it even possible to have such a personality, to develop that lattice work of mental model

You must have heard of famous WB quote

If past history was all there was to the game, the richest people would be librarians.

And similarly, if mathematics and probability was so important, all PHDs in maths would have been really rich. But as we see in Stock markets, that is not the case.

Similarly on other end of the spectrum, if behavior psychology was all there’s to it, Dan Ariely, Thaler and dobelli of the world should have been nailing it and replacing Soros and Buffet.

But as we know, that is not the case either. It is very difficult to put a finger on what works, it is an amalgamation of various mental models colliding together creating a synergy resulting in a stellar performance.

But is it Really.

In fact on a deeper look you realize that it is not even that because if understanding mental models was all that was required, amazing bloggers like Shane parish and Vishal Khandelwal should have replaced Prem Watsa by now (I do not know their returns, for all you know they are awesome) or atleast my good friend Soham Das, the mental model guy should have been a billionaire.

To which you might say, not narrating, but actually practicing that trait makes the difference.

Think about it, I am so tempted to say that Steve Wozniak would have been still working for HP and sharing his inventions with fellow geeks in a garage gang if it was not for Jobs marketing skills and similarly Jobs would have been some great sales man at best without the Wozniak’s genius.

In fact as soon as I pick up a success story and narrate its traits (as an amalgamation of creativity and technical skills) I indulge in narrative fallacy and survivorship and hindsight bias all packaged into one.

I had an interesting twitter chat about montecarlo simulation with math wizard Rehman Twitter handle @jace48

I usually stay away from (far too intelligent) people as they suffer from Physics envy, but this fella is different.

Montecarlo for the uninitiated is a random sampling computer simulation run on ur set of data to figure out all the possibilities. So let us say I have a system that buys and sells stocks fulfilling some criteria based on pre set rules. Now all that buying and selling will create a Equity curve with its slope and drawdown.

If I run a 1000 simulations of that, I will have a 1000 equity curves. The most optimistic ones would have least drawdowns and huge returns whereas the worst one wud barely beat inflation and have big deep cuts.

Remember, the strategy is same, buy and sell rules are same, but if your money is compounding every next bet size would be different and hence would have a totally different relationship with the curve.

A 30 bagger when you are already rich would catapult you into really RICH domain compared to lets say if you get that 30 bagger in your initial years. Peanut * 30 is just 30 peanuts you see!!

Similarly a drawdown in your initial starting days does not pinch. Losing 50% of your corpus is same mathematically in both cases. But psychologically, while you can see 01 lakh becoming 50,000 not many people can forego 50 lakhs out of their crore or 50 crore out of their 100 cr.

And when you get your biggest drawdown is not in your hands. Any investor, be it value, growth, momentum or whatever cannot tell you when the drawdown would come.

So what is the conclusion..

Well it is a journey for me as well, and I am learning. The bottom line is that we as prudent speculators can control the controllable only. Keep taking high probability trades over and over again independent of each other, and if the edge holds true, RISK Reward skew will ensure your well being. How fast and how slow would that happen would depend on LUCK, the monte-carlo roll of dice. Second important point is to remember that you ONLY have to get RICH once. Once you reach your financial independence mark, take that portion of chips off the table.

On a yet deeper note, your taking high probability trades also depend a lot on your genes & conditioning which I am afraid are not in your hands.

If you were born as Osama Bin Laden, you would have been Osama Bin Laden.

This Post Has One Comment

Its said that VAR was developed when Mr. J.P.Morgan asked for a single number that will help him understand the amount of overnight risk his portfolio contained. But is VAR really complete in all respects with regard to level of risk in the portfolio? As 2008 showed, VAR fails miserably when the underlying instruments cannot be rightly valued and in cases of markets suddenly becoming illiquid.

Now, lets move to Monte Carlo Analysis. Monte Carlo as you rightly pointed out points our alternative history paths than the one we have chosen. Now, this doesn’t make a zilch of difference once you have trodden the said path, but at the start of a journey, this provides a base on which to take risks.

Most systems are developed using Optimization. It maybe optimization of Time / Array Value / Sector-Stock-Indices or any of the other inputs (Stops / Targets, etc). Now, given all the information, the computer then tries to select the best. Since we know that the best is curve fitted, we could try to compensate it by choosing a differnet input which comes not at peaks but in large plateue’s (if you are using 3D style graphic of Optimization). But we still are making a single choice out of many.

As much as Technical Analysis is about the future being a reflection of the past, we do know that the paths aren’t the same. If you were to over-lay chart of say 1992 to 2000 over 2000 to 2008, you will see while both started and ended at peaks, the paths they took and the returns they genrated were different.

If ou equity curves could have taken 200 different routes with most of them ending in losses and one route which ended in profit, do we really think the future equity curve will be similar. One of the things I have often said and have observed is that draw-down in real time tends to be higher than one showcased in back-test. This single variable in itself can lead to atoo big a loss to overcome.

Monte Carlo just provides one with a bird’s eye of all altenatives of which only one may happen. To me, its a tool to better understand how good my system really is and how much capital can be allocated to the same.